How to profit from 4G technology

As more people use internet-enabled smartphones, the demand for mobile data traffic is only going to increase. So how can you profit from it? James McKeigue looks at the 'picks and shovels' specialists who provide essential components for mobile phone networks, and tips the best bet in the sector.

News this month that US telecoms group AT&T would start charging customers according to their internet usage drew howls of protest from 'smartphone' users across America. Three years after AT&T and other mobile operators introduced fixed-cost 'third generation (3G)' telephony, customers have become used to unrestricted internet use.

But the new regime is here to stay.

At first, mobile operators were glad to see sales of smartphones beat hopes, creating fresh growth in the maturing developed-world telecoms markets. But the features that made 3G so popular, such as internet access and the ability to swap videos and songs, have proved a major headache for operators. Since the introduction of smartphones, AT&T has seen a 5,000% rise in data usage. This is putting a huge strain on existing infrastructure, such as masts and backup stations. That's led to complaints of dropped calls as networks struggle to cope.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Amid the consumer backlash, operators claim they're being forced into changing tariffs. They point the finger at so-called 'iHogs' the 3% of customers who use 40% of the data capacity. Operators want to charge them more to pay for the extra infrastructure needed. This need is only set to grow as 3G is replaced, in developed markets at least, by 4G technology.

See also

There are two key variations of 4G, WiMAX and LTE, but essentially both use internet protocol and are designed to move data rather than just voice calls. This ongoing development means that the average mobile connection is expected to process 7GB of data a month in 2014, compared to 1.3GB today, as customers develop ever-higher expectations of what their mobile phones should be able to do.

Who pays for upgrading the infrastructure behind all this data traffic? The consumer will, of course, be the first port of call. So it's no surprise that AT&T's charging decision has been mirrored in Britain by O2, while France Telecom CEO Stephane Richard recently announced that the French operator was considering similar measures. AT&T has now embarked on a $2bn investment programme this year as it seeks to improve its data capacity.

Operators around the world are doing the same. But the tough credit environment means some are struggling with the costs. An alternative for operators is simply to rent more data capacity. American telecoms firm Clearwire is rolling out a mobile data network, while hedge-fund Harbinger Capital has plans for a hybrid 4G network that involves both satellite and mobile elements.

This isn't just about the developed world. The rapid spread of mobile phones in even the poorest parts of the world is a well-known phenomenon. But more relevant is the rising appetite for 3G and 4G in emerging powerhouses such as Brazil, India and China. Mobile infrastructure firms around the world are building, or competing in auctions to build 3G networks, as increasingly affluent emerging consumers upgrade to smartphones.

This combination of demand from both mature and emerging economies is one reason why global mobile-data traffic is growing nearly three times faster than global fixed-broadband data traffic. Critics might claim this is starting from a small base. But it's worth remembering that two billion internet-ready mobile phones have already been sold, compared to one billion laptops. Smartphone sales are also expected to overtake that of PCs this year, with almost 400 million shipments.

So how can you profit from the growth in mobile data traffic? A 'picks and shovels' approach is to buy into the technology specialists that build, or provide components for the networks. Below, we look at the best bet in the sector.

The best bet in the sector

A mobile phone network is actually made up of a host of networks linked together. The edge networks connect with customers and relay the information, via backhaul traffic, to the core network that processes and resends the information. Subsequently the backhaul is the vital link between the core and the edge and is often where bottlenecks occur. Ceragon (NASDAQ: CRNT) manufactures the high capacity radio systems needed to improve backhaul traffic data capacity.

Crucially, Ceragon's equipment works with either WiMAX or LTE, meaning that its market will not be affected by any battle between the two technologies. Another big plus for the company is the geological spread of its customer base. It is present in 85 countries around the world, with revenue generated from a mix of developed countries like the US with 16% and emerging economies in Asia Pacific, mainly India, accounting for 37%.

At $7.70 the stock is trading well below its historical highs of over $20 and with a p/e of 11.8 for 2011 for the year looks good value, especially when compared to competitors like Aviat Networks (NASDAQ: AVNW), which is on a multiple of 103 for 2011. Ceragon's sales dropped 15% in 2009 as the crisis forced operators to delay capital expenditure but the firm's strong product line, a customer base that includes AT&T and Clearwire and its geographical spread will help it grow with the increased mobile backhaul traffic.